Meaning :

Deficit financing is defined as financing the budgetary deficit through public loans and
creation of new money. Deficit financing in India means the expenditure which in excess of
current revenue and public borrowing. the government may cover the deficit in the following
ways.
1. By running down its accumulated cash reserve from RBI.
2. Issue of new currency by government it self.
3. Borrowing from reserve bank of India and RBI gives the loans by printing more currency
notes.
Objectives of deficit financing :
1. To finance war:- Deficit financing has generally being used as a method of financing war
expenditure. During the war time through normal methods of raising resources. It becomes
difficult to mobilize adequate resources. Therefore government has to adopt deficit
financing.
2. Remedy for depression :- In developed countries deficit financing is used as on instrument
of economic policy for removing the conditions of depression. Prof. Keynes has also advocated
for deficit financing as a remedy for depression and unemployment.
3. Economic development:- The main objective of deficit financing in an under developed
country like India is to promote economic development. The use of deficit financing in fact
becomes essential for financing the development plan especially in underdeveloped countries.
4. Mobilization of Resources :- deficit financing is also used for the mobilization of surplus,
ideal and unutilized resources in the country.
5. For granting subsidies :- In a country like India government grants subsidies to the
producers to encourage them to produce a particular type of commodity, granting subsidies is
a very costly affair which we cannot meet with the regular income this deficit financing
becomes must for it.
6. Increase in aggregate demand :- Deficit financing loads to increase in aggregate demand
through increased public expenditure. This increase the income and purchasing power of the
people as a consequence there is an increase availability of goods and services and the
production and employment level also increase.
7. For payment of interest:- Loan which are taken by the govt. are supposed to be repaid with
their interest for that government needs money deficit financing is an important tool to get

the income for the repayment of loan along with the interest.
8. To overcome low tax receipts.
9. To overcome the losses of public sector enterprises
10. For implementing anti poverty programme.
ADVERSE EFFECTS OF DEFICIT FINANCING
Deficit financing is not free from its diffects. It has its adverse effect on economy. Important
evil effects of deficit financing are given below.
1. Leads to inflation :- Deficit financing may lead to inflation. due to deficit financing money
supply increases & the purchasing power of the people also increase which increases the
aggregate demand and the prices also increase.
2. Adverse effect on saving:- Deficit financing leads to inflation and inflation affects the habit
of voluntary saving adversely. Infect it is not possible for the people to maintain the previous
rate of saving in the state of rising prices.
3. Adverse effect on Investment ;- deficit financing effects investment adversely when there
is inflation in the economy trade unions make demand for higher wages for that they go for
strikes and lock outs which decreases the efficiency of Labour and creates uncertainty in the
business which a decreases the level of investment of the country.
4. Inequality :- in case of deficit financing income distribution becomes unequal. During
deficit financing deflationary pressure can be seen on the economy which make the rich
richer and the poor, poorer. The fix wage earners are badly effected and their standard of
living detoriates thus no gap b/w rich & poor increases.
5. Problem of balance of payment :- Deficit financing leads to inflation. A high price level as
compared to other countries will make the exports more expensive and thus they start
declining. On the other hand rise in domestic income and price may encourage people to
import more commodities from abroad. This will create a deficit in balance of payment and
the balance of payment will become unfavorable.
6. Increase in the cost of production :- When deficit financing leads to the rise in the price
level the cost of development projects also rises this means a larger dose of deficit financing
is required on the port of government for completion of these projects.
7. Change in the pattern of investment:- Deficit financing leads to inflation. During inflation
prices rise and reach to a very high level in that case people instead of indulging into
productive activities they start doing speculative activities.

Is Deficit Financing Inflationary?

Deficit financing may not necessarily be inflationary there are certain conditions under which
deficit financing may not lead to inflation. With increase in money supply due to deficit
financing prices do rise but rise in price will only be temporary for about a period. As flow of
goods and services increase prices will began to fall. deficit financing is an important device
for financing development plans for underdeveloped countries and accelerate their rate of
economic development. But If deficit financing is not kept with in limits It may give rise to
prices, distorted investment and unequal and unjust distribution of income. therefore it is
essential that deficit financing is kept within limits and its impact on prices and costs are
softened through various controls.